While Texas law offers robust liability protection for business entities, courts can still "pierce the corporate veil" through alter ego claims when businesses fail to operate as truly separate entities.
Understanding how the alter ego claims arise and implementing preventative measures isn't just good governance – it's essential asset protection that safeguards everything you've worked to build, both professionally and personally.
What Is an Alter Ego Claim?
An alter ego claim is an attempt to hold individuals personally liable for corporate actions.
When you form a corporation or limited liability company (LLC) for your business, you create a shield for your personal assets. For example, if your corporation defaults on a commercial lease, creditors cannot reach into your personal bank account to pay the debt.
But creditors can go around the shield, or “pierce the corporate veil”, in rare circumstances.
What Does Alter Ego Mean?
Per Texas case law, "alter ego" refers to a legal doctrine that's used to pierce the corporate veil – a remedy that allows courts to disregard an entity’s liability protection and hold individual members personally liable for the company's actions or debts.
The alter ego theory applies when there is "such unity between the corporation and the individual that separateness between the two no longer exists and holding only the corporation liable would result in injustice." (Castleberry v. Branscum, 721 S.W.2d 270 (Tex. 1986))
Essentially, the court determines that the corporation functions as an extension of the individual rather than as a separate entity.
How Do You Prove an LLC Or Corporation Is an Alter Ego?
When examining whether the alter ego doctrine applies, Texas courts consider several factors:
- Whether corporate formalities have been followed and to what degree
- Whether corporate and individual property have been kept separate
- Amount of financial interest, ownership, and control the individual has over the company
- Whether the corporation has been used for personal purposes
“Alter ego” is the most common basis that plaintiffs use when they try to pierce the corporate veil.
How Do Alter Ego Claims Relate to Piercing the Corporate Veil?
To pierce the corporate veil in Texas, a plaintiff must do three things:
- Sue the company for an established legal reason (“cause of action”), like fraud. Alter ego is not a cause of action by itself.
- If the plaintiff proves its case, it can claim an individual should be held personally liable. The most common claim is alter ego.
- The plaintiff must also satisfy the “actual fraud rule.” It says that the corporate liability shield can only be pierced if the individual perpetrated an actual fraud on the plaintiff and did so primarily for direct personal benefit.
Thus, even if a court decided your corporation was your alter ego, your personal assets would still be protected unless the plaintiff satisfied the “actual fraud rule.”
If an LLC or Corporation Has One Member or Shareholder, Is It an Alter Ego?
Not necessarily.
While courts look at the degree of control the individual has over the company, the other factors (listed in the previous question) are also important.
Can I Be Personally Liable Even If the LLC or Corporation Is Not My Alter Ego?
Yes.
Texas’s liability shield only applies to obligations related to the company’s contracts. It doesn’t protect you from liability based on a statute, liabilities you explicitly accept, or liabilities for personal conduct that causes injury. For example, you could be personally liable if:
- You vote for or assent to a distribution that leaves the company insolvent.
- The corporation does not pay franchise taxes and file reports.
- You commit fraud, injure someone, or damage someone’s property (or knowingly participate in doing so).
- You sign a contract for the company without disclosing that you are an agent of the company.
- You agree to be personally liable for a debt, like co-signing for the company’s business loan.
How Can I Avoid Alter Ego Claims?
Follow Corporate Formalities
- File a certificate of formation with the Texas Secretary of State and pay the fee.
- Have a registered agent in Texas. It must be a physical office staffed during regular business hours. It does not have to be your business location.
- If you are structured as a corporation, create corporate bylaws; if an LLC, create an operating agreement. You do not have to file them with the state in Texas.
- Issue and keep records of stock or membership certificates.
- Corporations: Hold annual shareholder and director meetings. LLCs: Hold regular member meetings.
- Corporations: File taxes for the corporation separately from your personal taxes.
Keep Corporate and Personal Property Separate
- Open a separate bank account for the business, in the business’s name.
- Keep your corporate books separate from your personal books.
- Never use company money for your personal expenses, or vice versa.
- Conduct company business under the company’s name. For example, if you lease office space, make sure the lease is in the name of your legal entity, not yours.
- Don’t co-sign loans for the company or tell investors that you will back the company with your personal assets.
Observe Documentation Best Practices
- Keep your financial books in good order.
- Retain governance documents (such as certificate of formation, bylaws or operating agreement, and stock or membership certificates) forever.
- Corporations: Take notes at annual shareholder and director meetings and retain them for at least 7 years. LLCs: keep minutes for member meetings and record major business decisions.
- Retain copies of contracts, invoices, receipts, and other business documents for at least 7 years.
- Retain tax returns and associated documentation for at least 10 years.
Avoid Common Mistakes
- Using a mail drop or an answering service as a registered agent. The registered agent must be staffed during business hours so your business can be served with legal documents.
- Not creating bylaws and stock certificates (for corporations) or operating agreement and membership certificates (LLCs). Since you don’t have to file these documents in Texas, businesses sometimes forget to create them.
- Failing to pay the franchise tax and file required reports.
- Mixing company funds and personal funds.
Protect Your Business and Personal Assets from Alter Ego Claims
Don't wait until it's too late. The liability shield that protects your personal assets from business debts isn't automatic – it requires vigilance and proper corporate practices.
Take action now to strengthen your business's legal protection:
- Schedule a corporate formalities review
- Separate your personal and business finances completely
- Update your governance documents
- Establish proper documentation protocols
The experienced business attorneys at Hendershot Cowart P.C. are ready to help you identify compliance gaps and create a customized plan to protect what you've built. Don't risk losing your personal assets to an alter ego claim.
Contact us today for a consultation to safeguard your business and personal wealth.